Real Estate ETFs: 3 Things To Consider

For retail investors, the exchange traded fund boom has opened up a plethora of opportunities for portfolio construction. From simple indexing approaches to more complex strategies, ETFs are quickly becoming the go-to investment vehicle. Nowhere is that more prevalent than the world of real estate. Overall, the continued evolution of the ETF industry has allowed investors to gain cheap and easy access to the commercial and residential real estate markets within one single ticker [see The Best Dividend ETF For Every Investment Objective].

What’s the Appeal?

For many investors, real estate has become an integral part of a well-diversified portfolio and offers several distinct advantages.

First, real estate can provide stable and high income. Created in the 1960s as a way to allow regular retail investors to participate in the commercial real estate market, real estate investment trusts (REITs) are traded on the major exchanges like stocks and invest in real estate directly – either through physical properties or through mortgage investment. In exchange for offering investors high-dividend distributions, REITs receive special tax considerations [also see 5 High Yielding Real Estate ETFs].

Secondly, real estate offers the potential to hedge against rising inflation as rents are generally designed to keep pace with increasing prices. Not to mention that owning physical property and goods can be quite beneficial in periods of high sustained inflation. Finally, as a non-correlated asset class, real estate adds a level of diversification to a portfolio and can actually “smooth-out” returns over long stretches of time.

All of these benefits on their own are worth adding real estate and REITs to a portfolio; however, combining them with the low cost, intraday tradability, diversification advantages of ETFs, and investors have perhaps the perfect way to gain exposure to the asset class [see 5 Important ETF Lessons In Pictures.

Nonetheless, that “perfection” still has limits.

Rising and falling interest rates, home values and consumer confidence can play havoc with real estate returns in the short run. For example, the 2008 housing crisis sent the industry into a tailspin and many real estate investments turned sour. However, the sector has managed to rebound since those lows and historically real estate has been pretty stable place to park your money.

Not All Real Estate ETFs Deliver High Yields

Though one of the biggest appeals of real estate ETFS is their yields, there is a very broad range when it comes to those dividend payments. For example, the iShares Cohen & Steers Realty Majors (ICF, B)–which bets on some of the largest REITs in the U.S.–currently only yields 2.15%, while the mortgage REIT tracking iShares FTSE NAREIT Mortgage Capped Index (REM, A-) yields a staggering 12.68%. Some, like SPDR S&P Homebuilders (XHB, A+), which is more of a play on housing construction rather than the ownership of physical buildings, yields barely anything at all. For those looking for dividends, the following are good places to start:

Going Global

Currently, the United States only represents about 30% of the global real estate market. Given that small amount, real estate investors may want to break out their passports. Since the mid-’90s, nearly 30 countries–from Singapore to France–have adopted the REIT tax structure. This has opened up these various markets to global investors and has helped the sector’s market capitalization has expand several fold. According to indexer FTSE, there are now over 280 international REITs creating an $825 billion global marketplace.

Aside from tapping these various markets for diversification benefits, investors may also want to expand their REIT focus to include international firms for another reason – a weakening U.S. dollar. According to industry group NAREIT, from 1990 to 2009–when the U.S. dollar was falling against the Japanese yen–average total returns for investors were 12.1% per year for investments in Asian REITs. However, 10.4% of that return was from currency gains and just 1.7% was from the REITs themselves. The industry group found similar results for Europe [see Ex-U.S. Portfolio].

Those added currency gains have helped funds like the SPDR Dow Jones International Real Estate (RWX, A-) and the iShares FTSE EPRA/NAREIT Developed REIT ex-US (IFGL, A) provide great returns as well as bigger yields than their domestic counterparts. Currently, both RWX and IFGL yield 6.2% and 5.51%, respectively.

The Bottom Line

For investors, the appeal of adding real estate to a portfolio is simple: the asset class can provide stable, high and inflation-fighting income, all while providing diversification and correlation benefits. All of these advantages are only enhanced when placed in the exchange traded funds. While the sector has experienced a few hiccups in the recent past, real estate deserves a place in modern portfolios.

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